US rig count near 19-year high and climbing

Baker Hughes Inc. reported 1,295 rotary rigs drilling in the US during the week ended Feb. 18, the highest weekly rig count since late February 1986, when the count was at 1,308.

There are major differences between the two periods, however. In 1986, US drilling activity peaked during the first week at 1,915 rotary rigs, then plunged to 663 that summer as Saudi Arabia opened its taps and pushed down crude prices in a battle for market share. US drilling rebounded slightly to 988 at the end of 1986, but crude prices and rig counts remained depressed for years afterward.

This year, the US rig count opened at 1,242 rotary rigs, has trended slowly upwards over the first 2 months, and generally is expected to keep climbing. Needless to say, both crude and natural gas prices are nominally much higher today than in 1986 and also are likely to remain so.

Rig day rates improveThe number of drilling permits issued by the 30 states monitored by Lehman Brothers Inc., New York, increased by 3.2% during January, adjusted for comparable numbers of filing days. The biggest increases were in Wyoming, (up an adjusted 26%), Texas (up 11%), and Oklahoma, (up 14%). "The modest increase in January suggests an improving US rig count in the coming months," said Lehman Brothers analysts.

Drilling contractors are cashing in on currently increased activity through higher day rates for their rigs. Transocean Inc., Houston, recently announced that its 10,000-ft capacity Discoverer Spirit drillship in the Gulf of Mexico was awarded an 18-month contract for an all-time global high rate of $270,000/day, up from the previous record of $240,000/day. "The company sees day rates for ultra-deepwater rigs approaching $300,000," said Lehman Brothers analysts.

"In the North Sea midwater market, day rates could rise to 1997-98 peak levels of $140,000-150,000 by the end of 2005, up from the $110,000 [level]," the analysts said. "Today, most international jack up [rig] markets are near full utilization, and there is incremental demand for units in the Middle East, Southeast Asia, and West Africa. Accordingly, we expect additional day rate gains across the regions."

Oil price, demand both growDespite a nearly 60% jump in crude prices during the past 2 years, US demand increased by 1.8% in 2004, including a sharp acceleration of more than 3% from year-ago levels in the second half of last year, when prices were hovering near $50/bbl, said analysts in the Houston office of Raymond James & Associates.

-- Real per capita income and automobile [performance] efficiency increased at higher rates than oil prices, so that a smaller percentage of a person's income is now spent on energy.

-- In 1973-74, the Middle Eastern oil embargo caused prices roughly to triple to $10/bbl from $3/bbl. The Iranian revolution of 1979 also almost tripled oil prices to $35/bbl from $12/bbl. "By comparison, the recent move from $35 to $45[/bbl] is an increase of only 29%. Even when measured from the September 2003 trough of $27[/bbl], prices have increased by about 65%," analysts said.

-- As the US economy has shifted from manufacturing to services, energy intensity has declined so that energy is a smaller part of the overall US economy.

-- The labor market, specifically unionized labor, has less impact on inflation, with fewer labor contracts geared to changes in the consumer price index [CPI].

-- Increased worker productivity through application of new technology over the last 5 years has offset higher material costs.

-- Corporate margins are being squeezed so that it's harder for companies to pass along higher energy costs to consumers.

-- The "Wal-Mart effect" of "big box" stores has "whittled down middleman costs and outsourced many of their products from lower-wage countries."

Brown asked, "Are we really measuring the CPI correctly? Even though it is probably a very small part of the oil price-to-inflation decoupling, one can argue that today's CPI is not capturing the full price increase that the consumer is experiencing. Today's CPI is probably not reflecting a meaningful increase in rent, healthcare, or technology costs."